The Implications of Shifting Frontiers in Financial Markets for Monetary Control (1986)

The purpose of this paper is to try to weave the theoretical work of that emerging school of monetary economists who have espoused the ‘Legal Restrictions’ theory of the demand for money and monetary policy together with practical observations taken from the experience of the UK in recent years. Professor Neil Wallace, Professor of Economics at the University of Minnesota, coined this term, ‘The Legal Restrictions Theory of Money’, in a paper in the Federal Reserve Bank of Minneapolis Quarterly Review (1983). There had been forerunners of this approach in the literature much earlier, for example the article on ‘Problems of Efficiency in Monetary Management’ by Harry Johnson (1968), and in an extraordinarily prescient article by Fischer Black on ‘Banking and Interest Rates in a World Without Money’ (1970). More recently, this theoretical approach has been taken further by economists such as Fama (1980), Hall (1983), Kareken (1981), Sargent and Wallace (1982 and 1983), Wallace (1983), and other economists, with a centre in Minneapolis: the arguments and analysis of this developing school have been summarised and pooled together in a brilliant survey paper, ‘A Libertarian Approach to Monetary Theory and Policy’, by Jao (1984). This new school, which also has strong links with the ‘new view’ of money creation put forward by James Tobin (1963), ascribes both the particular characteristics of bank deposits, and also some special features of currency, together with the observed regularities between such money holdings and nominal incomes, to legal restrictions placed upon the banking system; they go on to suggest that such regularities will collapse as, and when, the restrictions are lifted, or eroded by innovation.